ISA deadline looms so ensure you do not lose out on tax allowance

ISAs were introduced in April 1999 and everyone aged 18 and over (16 for cash ISAs) are eligible to subscribe. The returns are both free from income tax and capital gains tax. Withdrawals can be made at any time without loss of tax relief unlike, say, Venture Capital Trusts where the money has to be invested for at least five years.

There are two components:

n Stocks and shares (where the whole ISA allowance can be invested);

n Cash (where up to half can be deposited).

In this tax year, up to £11,280 can be subscribed (up from £10,680). If you do not have this sum, a smaller amount can be invested, subject to any conditions made by providers. As the title states, the allowance is per person and joint ISAs are not permitted.

Only one provider can be used for each component although it is possible to combine both with a single provider. This does not necessarily mean that only one share or fund can be accessed if the provider uses a ‘platform’ or similar scheme where many, indeed thousands, of alternative choices are available. Private client specialists Hargreaves Lansdown, for instance, offer over 2,600 funds.

With the current derisory rates of interest on cash ISAs, there is no point in using the allowance this way. In fact, even the best paying one will guarantee your money loses value. With inflation (excluding mortgages) at three per cent, a basic rate taxpayer needs to earn an annual 3.75 per cent interest to avoid losing money and a higher rate taxpayer needs five per cent.

Watch for past ISA plans for the rate once any bonus expires. Savers risk losing £500m, according to MoneySupermarket.com. Its research reveals savers could see their rate fall to just 0.25 per cent once the bonus goes.

Instead this year opt for a stock market ISA and transfer any low cash ISAs from earlier years across. If anyone has a doubt, just look at the record. If £100 had been invested in a savings account in 1950, it would now be worth £1,560 but the same sum in equities (assuming dividends were reinvested) has turned into £113,500.

Review your existing portfolio to see if any bias has crept in or if there are any obvious gaps. Do not over-diversify. Chelsea Financial suggest a maximum 10-15 funds for anyone with less than £100,000 savings. Ensure a spread across key asset classes, such as equities, fixed interest and commercial property but in proportion to meet your objectives and attitude to risk.

If choosing a new fund or stock, invest in one you fully understand and which fits your goals. If the dividend is not required, ensure you opt for an ‘accumulation’ form of fund as by reinvesting, your returns are compounded – the classic ‘snowball effect’.

Albert Einstein said, “Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it.”

A glance at recent history is also a good indicator as to which sectors have performed well. Research by the Association of Investment Companies specially for the Yorkshire Post shows the leading areas over three years after deducting typical 3.5 per cent charges were:

n Global smaller companies, up 85.5 per cent;

n UK smaller companies, up 82.3 per cent;

n Private equity, up 75.8 per cent;

n Biotechnology and healthcare, up 64.9 per cent;

n North American smaller companies, up 59.5 per cent.

Not far behind were UK growth and income and Asia Pacific excluding Japan.

Taking a decade retrospective on the same basis, the stars are global emerging markets (up 587 per cent), Asia Pacific (up 546 per cent) and UK smaller companies (a rise of 385 per cent).

The benefits of using an investment trust over a closed-ended fund like a unit trust include the ability to borrow, distributing dividends at the optimum time and having elected independent directors.

With any investment collective, risk is reduced and volatility cut. The cheapest way into the stock market is by purchasing an index which seeks to replicate the underlying holdings. An exchange traded fund (ETF) is just such a vehicle but check it is buying the physical stock and not synthetically recreating it with the attendant risks.

Charges are lower as no experienced stock-picking manager is employed. Ask for the ‘total expense ratio’ (TER). It is around 1.7 per cent for most managed funds but just 0.15 per cent for Vanguard with its ETF.

However, the downside with an index of, say, the FTSE 100 is that your money is purchasing indiscriminately the largest capitalised firms and in the process there will be too much concentration in a few sectors to the exclusion of good growth potential. A manager can achieve a more balanced holding. For those making their first ISA equity investment or where there is insufficient money to invest across a range of funds, Elizabeth Hastings of financial advisers AWD Chase de Vere in Leeds tips Cazenove Multi-Manager Diversity where one-third each is invested in equities, alternative investments and cash/fixed interest.

For those already with a portfolio, Hastings likes AXA Framlington UK Select Opportunities, BlackRock UK Special Situations, Henderson European Growth, HSBC American Index, First State Global Emerging Market Leaders, Kames Strategic Bond, Jupiter Strategic Bond and M&G Property Portfolio.

Fixed income has experienced a phenomenal rally in the last two years but Chelsea Financial warns that this is unsustainable and savers in this asset class “need to set their sights lower in future”.

Investment grade and high yield bonds are slightly better although the former looks expensive. A strategic bond fund in an ISA could be a good ISA bet. Invesco Perpetual High Income celebrates its 25th anniversary this year. It’s not only the best performing fund in its sector since launch but of any fund investing in the UK. If £10,000 had been invested at launch and no income taken, it would now be worth over £205,000.

Positive returns look likely for equities this year. M&G Global Dividend and Newton Global Higher Income should show the good earnings available from quality companies.

For a contrarian investment, Japan could be worth holding. Consider GLG Japan or Jupiter Japan Income.

Apart from smaller firms (like Aberdeen Asian Smaller Companies, up 45 per cent last year), if taking a long-term view, ensure a proportion goes into emerging markets. Star funds over the last three years include First State Global Emerging Markets Sustainability (up 60 per cent), Aberdeen Emerging Markets (up 52 per cent) and McInroy & Wood Emerging Markets (up 49 per cent).